Data Warehousing, BI and Data Science

21 October 2017

Swaps and Options

Filed under: Business Knowledge — Vincent Rainardi @ 6:12 am

Working in investment world often requires us to understand various asset classes. Sometimes we come across simple asset classes, such as shares, bonds, currency and commodity. But sometimes we come across complex asset classes / derivatives, such as swaps and options. In this article I’d like to give a flavour on swaps and options. There are other derivatives such as futures and forward, but I won’t be covering them today.

Swaps

Swaps are essentially an exchange of two assets. The asset produces an income, so what really being exchanged is the income (the cash flow). In fact, we don’t have to have an asset. We just need to have a cash flow. For example, if the fixed income from a bond is exchanged to a floating interest rate.

Swaps comes in many different variations, but it is always in the form of A is exchanged to B. Typically A is floating price, and B is fixed price. Here’s some of them, alphabetically:

  • Asset Swap: a bond (fixed coupon) in exchange to a floating interest rate (LIBOR plus spread). Link
  • Commodity Swap: a commodity (floating price, usually oil) in exchange to a fixed price. Link
  • Credit Default Swap (CDS): a credit protection (from a bond going default) in exchange to a fixed payment. Link
  • Cross Currency Swap (CCS): a loan in currency A (fixed interest) in exchange to a loan in currency B (fixed interest). Link
  • FX Swap: a spot FX (today) in exchange to the same amount of a forward FX (tomorrow). Link
  • Inflation Swap: the inflation rate (such as RPI) in exchange to a fixed rate. Link
    Zero Coupon Inflation Swap is one lump sum payment at the end. Link
  • Interest Rate Swap (IRS): a floating interest rate (LIBOR + spread) in exchange to a fixed interest rate. Link
  • Total Return Swap: the income of an asset, plus the capital gain, in exchange to a fixed or variable payment. Link
  • Variance Swap: a variance of a price (the volatility) in exchange to a fixed payment (the strike). Link

Options

Options is the right to buy or sell at certain price on a certain date.
The right to buy is a call. The right to sell is a put.
American: buy/sell before a certain date. European: on a certain date.

  • Bond Option: the right to buy/sell a bond at a certain price before a certain date. Link
  • Commodity Option: the right to buy/sell a commodity (e.g. oil or metal) at a certain price before a certain date. Link
  • Equity Index Option: the right to buy/sell an equity index (such as S&P 500) at a certain price before a certain date. Link
  • FX Option (or currency option): the right to exchange a currency into another currency (fixed amount) at certain rate before a certain date. Link
  • Interest Rate Option: the right to buy/sell a time deposit (EuroDollar, CD, T-Bill, EuroSterling) with a certain rate before a certain date. Link
  • Swaption: the right to enter a swap (typically Interest Rate Swap). Link
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